A commodity futures contract is an exchange to purchase or sell a decided amount of a commodity at a particular price on a specific date in the future. investor apply such contracts to avoid the risks connected with the price variations of a futures' underlying product or raw material. Sellers do futures contracts to lock in confirmed prices for their commodities.
BREAKING DOWN Commodity Futures Contract
Commodities futures contracts can be done by stockholders to get directional price risks on raw materials. Trading in commodity futures contracts can be extremely risky for the new. One reason for this risk is a large amount of leverage associated with holding futures contracts. For example, for an original margin of about $3,700, a trader can open into a futures contract for 1,000 barrels of oil priced at $45,000 (with oil valued at $45 per barrel). Given this high amount of leverage, a very small movement in the rate of a commodity could result in large increases or losses compared to the original margin. Unlike choices, futures are the responsibility of the buying or sale of the underlying asset. Just not closing an actual position could result in a new investor taking delivery of a large amount of undesired commodities. Thought using short positions in futures can lead to countless losses.
Commodity Futures Hedging Example
Purchasers and sellers can apply commodity futures contracts to secure in the purchase of sale values weeks, months or years in advance. For example, suppose that a farmer is assuming to produce 1,000,000 bushels of soybeans in the next 12 months. Typically, soybean futures contracts involve the quantity of 5,000 bushels. If the farmer's break-even point on a bushel of soybeans is 10 per bushel and he understands that one-year futures contracts for soybeans are currently priced at 15 per bushel, it might be wise for him to lock in the 15 sales rate per bushel by selling complete one-year soybean contracts to include his season. In this case, that is (1,000 / 5,00 = 20 contracts).
One year later, regardless of price, the farmer gives the 1,000,000 bushels and takes $15 x 200 x 5000, or 15,000,000. This rate is locked in. But except soybeans are valued at $15 per bushel in the place market that day, the farmer has either taken less than he could have or more. If soybean were valued at 13 per bushel, the farmer receives a $2 per bushel advantage from hedging, or 2,000,000. Furthermore, if the beans were rated at 17 per bushels, the farmer drops out on an extra 2 per bushel profit.
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